China’s shadow banking poses risks as unregulated loans fuel bubbles, says CLSA

China’s fast-growing shadow banking system may cause economic shocks, as unregulated financing from the sector is fuelling industrial overcapacity and an inflated property market, said a senior analyst at Hong Kong brokerage CLSA.

Francis Cheung , head of China and Hong Kong strategy at CLSA, said: “Our estimate is if China cleans out the bad debt in this sector in one go, there is a potential loss of 3.7 per cent of GDP.”

However, he does not think it poses a big systemic risk, given the size of China’s balance sheet.

The biggest risk in the shadow banking industry lies in its “lack of visibility” and that could bring shocks to the economy further down the line, Cheung told reporters today at the annual CLSA Investors’ Forum.

CLSA estimates that shadow financing had reached 54 trillion yuan in China at the end of last year, 79 per cent of GDP, and that 64 per cent of such assets originated from or were related to banks, according to a report it issued on Tuesday.

The valuation is close to the 78 per cent of GDP estimated by Moody’s, but higher than some international institutions’ estimates. “China’s shadow-banking activity is opaque and bypasses the central bank’s disclosure of total social financing,” the report said, suggesting the size of the industry is often understated.

Banks can hide risks and avoid regulatory restrictions by lending money through purchasing the rights to a loan held by, for example, a trust company, Cheung said.

“Anywhere there is credit in the system, we are worried because there is no provision [of capital set aside to cover uncollected loans],” he added.

He said shadow financing would bring “shocks” because it funded overcapacity in numerous sectors of the Chinese economy, the worst one being real estate.

Property sales grew by more than 25 per cent nationwide in the first eight months of this year. Although this has offset some pressure on the economy, analysts are worried about the risks of a bubble.

A report issued by UBS on Tuesday said: “The recovery in the property market has been uneven, with some bubbly developments appearing. While many tier-3 and tier-4 cities are still struggling to digest oversupply, property prices in a number of cities have risen by 30-40 per cent year-to-date, and in some districts over 50 per cent, with the rally spreading to more cities.”

By adding the shadow financing of debt and government bonds into China’s official “total social financing” (TSF) – a term invented by the authorities to measure credit supply - CLSA found that total financing is 29 per cent higher and growing much faster than the reported TSF.

Twenty per cent of Chinese household wealth is invested in shadow-financing products, compared with 22 per cent in deposits and 5 per cent in bonds, CLSA’s data shows, which piles pressure on the government’s implicit guarantee for principal or yield.

As for the stock market, Cheung said the MSCI China’s price to earnings ratio has already surpassed the five-year average and is at last June’s A-share peak of 12.3 times.

“The market rally could run to the end of the third quarter as the economy will slow significantly by the fourth quarter, especially as the property market slows,” he said.

Cheung recommended stocks in the internet, telecoms, alternative energy, pharmaceutical and Hong Kong property, while avoiding those in cyclical sectors.

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